The four percent rule, used to determine how much in savings a retiree can safely withdraw annually while ensuring an adequate nest egg throughout retirement, remains a “reasonable” starting benchmark for guiding retirement income planning strategies.
So concludes the American Institute for Economic Research in a new report, “From Savings to Income: Retirement Drawdown Strategies.” The report examines the performance of 8 retirement income drawdown strategies when applied to actual market returns achieved from 1928 and 2013.
The study measures the drawdown strategies based on a “utility score” that reflects average annual spending and minimum annual spending. The strategies include constant dollar/inflation-adjusted, constant percentage, smooth percentage, constant-percentage floor, inflation-adjusted percentage, increasing percentage and required minimum distribution (RMD) percentage.
“Although the average utility score for a constant dollar strategy is highest at a 4.5 percent withdrawal rate,” the best strategy for poor outcomes was found at a lesser rate of 3.5 percent,” the report states.
The report adds that advisors should only recommend withdrawals of three percent or less for the most risk-adverse retirees or when investment returns are “well below” the historical average. Conversely, initial drawdowns exceeding 5 percent would be suitable for risk-tolerant investors who can accommodate changing market returns.
Turning to average and worst-case scenarios, the research observes that a constant percentage (“floor”) strategy yields the highest average utility score for many historical periods. Combining elements of a constant dollar and constant percentage strategy, the floor strategy establishes a minimum withdrawal, but permits greater spending when returns are above average.
The report cautions, however, that the strategy can exhaust assets when the floor is set too high and returns are poor.
“This strategy would have fared well for all retirements from January 1930 through June 1935, lasting at least 40 years,” the report states. “This strategy would have exhausted assets, however, after only 23 years for retirements beginning in November or December 1936. It’s a relatively high-risk strategy that would have happened to perform well on average during the historical simulations.”